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Fed: Small banks crack down on mortgage lending

By Annalyn Censky, staff reporterNovember 8, 2010: 4:34 PM ET

NEW YORK (CNNMoney.com) -- Even with interest rates at historic lows, you might still have a hard time getting a mortgage: Small banks have tightened standards when it comes to lending to homebuyers, according to a survey issued Monday.

After easing their standards in July, commercial banks reversed that trend in October, the Federal Reserve reported Monday after surveying loan officers at 77 banks.

Smaller banks -- those with annual sales of less than $50 million -- mostly tightened their standards for traditional mortgages in the last three months, and large banks -- those with assets of more $20 billion -- widely left their standards unchanged, the Fed said.

Signaling that banks are continuing to crack down on the riskiest mortgages, less than half of the banks participating in the survey made sub-prime loans in the last three months.

Banks' willingness to lend money has become a focal point in the economic recovery. Economists warn that sluggish consumer and business spending are both holding the recovery back, and some say, tighter credit conditions are part of the problem.

But at the same time, banks maintain that they are lending even as the appetite for new loans has dropped off.

In the latest Fed survey, many banks reported weaker demand across a broad range of loans, including mortgages, credit cards and business loans.

That drop in demand is "disturbing," said Paul Ashworth, senior U.S. economist with Capital Economics, especially after the Fed announced at least $600 billion in monetary stimulus last week. The policy, known as quantitative easing, is meant to boost consumer and business spending by making it cheaper to borrow money.

"On this evidence, claims that quantitative easing will lead to a new boom in bank lending look well wide of the mark," Ashworth said in a research note. " In practice, lenders remain reluctant to lend and borrowers remain reluctant to borrow."

At the same time that banks tightened or left standards unchanged for mortgages, almost all the banks in the Fed survey reported easing standards on commercial and industrial loans over the last three months.

And while some smaller banks tightened their standards for approving credit cards, most large banks eased their standards in that category.

Banks cited a "less uncertain economic outlook" and increased competition from other banks, as reasons for easing their standards, but said they don't expect still-tight lending standards to return to their pre-recession averages for the "foreseeable future."